"Total insanity" Says Warren Buffet's Top Lieutenant About Bitcoin

Charlie Munger, a man who is by many thought to be billionaire Warren Buffet's right-hand man, made a statement at a University of Michigan's Ross School of Business event. When asked what he thought of bitcoin, Munger replied that bitcoin is in a "crazy bubble", and is a "bad idea".

Does Munger have a point, or does he belong among the ranks of other misinformed classical banking naysayers like Jamie Dimon and Bank of America CEO Brian Moynihan? Read on as we unpack Munger's argument.

"Total Insanity"

During the university event, one of the attendees asked Munger for his thoughts on bitcoin, that is what triggered his vitriolic response. After comparing bitcoin to a plague, he noted that bitcoin is a trap, luring people into lies of easy wealth.

It would seem that Munger believes bitcoin and other cryptocurrencies to be something like a self-powered Ponzi scheme. Munger's argument begins to fall apart when he starts making comments about comparing gold and bitcoin.

You know it is one thing to think gold has some marvelous store of value because man has no way of inventing more gold or getting it very easily, so it has the advantage of rarity. Believe me, man is capable of somehow creating more bitcoin. … They tell you there are rules and they can't do it. Don't believe them. When there is enough incentive, bad things will happen.

Let's take this apart and see what's really going on in this statement. First, we need to consider two separate things. Why is gold valuable, and why can't we "invent more"? Then, why can't we make more bitcoin? And if we could, what would happen?

Inventing Gold

According to Munger, humans cannot create gold. This is where a part of gold's value is derived from. It is deflationary, and it exists in a finite amount and it has both aesthetic and industrial uses. This is a fair enough set of assumptions, but it is incomplete.

According to sources, humans can make gold. The problem is, we can only make it a few atoms at a time, and at a far higher cost than mining. For the sake of argument, let's imagine that a machine is revealed tomorrow that can transmute iron into gold. What would this do to the value of gold? Probably very little, in the long term.

To understand why, we need to consider another precious, natural material that is still highly valued today, but can be produced in a laboratory: diamonds.

In 1954, Howard Tracy Hall created a reliable and reproducible process by which diamonds could be created. Today, these artificial diamonds are used all across the world for numerous industrial applications.

But why are natural diamonds, the kinds used in jewelry, still worth a fortune? In fact, diamonds today are worth between 3 and 25 thousand dollars per carat. The reason behind this is simple - diamonds are valuable for the same reason that a celebrities used sock is valuable, people care about where things come from. They care if its "original" or not.

"Original" Bitcoins

Let's imagine for a moment that we don't care about the absurdity of the idea of making new bitcoins, beyond the set amount that is mined with every block. If someone were somehow able to do this, the network would not view them as legitimate. They would be the fool's gold of bitcoin and thus would have no value.

Experts can distingtuish lab-grown diamonds from natural ones, and the bitcoin network knows the difference between a real and a fake bitcoin.

Today anyone can create a cryptocurrency. Tens of thousands or more already exist today day. More and more are created every minute. Many offer technological advantages, use cases, or innovations far above and beyond bitcoin, and yet they are valued less.

Why? It's the same reason why a lab-grown diamond is worth less than a natural one.

Charlie Munger is a brilliant investor - few would argue that point. But like many of his generation and background, he too lacks a fundamental understanding of how bitcoin works.

Featured Image via a CNBC